Options Theory Research Articles

Cash holdings in the US healthcare industry: Do different types of uncertainty matter?

This study examines the effects of economic policy uncertainty, categorical economic policy uncertainties, and pandemic uncertainty on the cash holdings of firms operating in the US healthcare industry. The SYS-GMM methodology is applied for 466 firms from 2001 to 2022. The results show that all uncertainties positively affect cash holdings contemporaneously, albeit at different magnitudes. Monetary policy, healthcare policy, and fiscal policy uncertainties are the most influential uncertainties, supporting the financial frictions and real options theories. Controlling for the severity of the pandemic over time, pandemic uncertainty has a positive contemporaneous effect and a negative lagged effect on cash holdings.

Geopolitical risk, uncertainty, real options, and corporate social responsibility

AbstractMotivated by intensified interest in corporate social responsibility (CSR) and with the backdrop of rising geopolitical risk (GPR), we examine the impact of news‐based GPR on CSR activities among US public firms between 1995 and 2019. In line with real options theory, we confirm a negative relationship between GPR and CSR, that the effect is more pronounced for more irreversible investments, and it is channeled through lower profitability, reduced cash flow and asymmetric information. We further assess the differential impact across resource and financial constraints, political regimes, multinational operations, pre‐existing levels of CSR, industry membership, and over time.

Uncertainty and Green Innovation Nexus: The Moderating Influence of Ownership Structure and Product Market Competition

ABSTRACTRecently, there has been a growing interest among researchers, academics, and corporations regarding whether and how uncertainties influence corporate decision‐making. This study seeks to explore how various forms of uncertainty, including firm‐specific uncertainty (Fs_u), market‐based uncertainty (M_u), and economic policy uncertainty (Ep_u), influence corporate green innovation. This study also examines whether state ownership and product market competition moderate the relationship between uncertainty and green innovation. Using a sample of Chinese‐listed manufacturing firms from 2003 to 2020, the findings show that uncertainties (Fs_u, M_u, and Ep_u) negatively affect corporate green innovation. This negative effect is weakened by state ownership, whereas is strengthened by product market competition. The results remain consistent and valid following thorough robustness checks and additional analyses. This research contributes to real options theory by delineating how internal and external uncertainties impede green innovation.

Contingent convertible Ijara pricing model

Purpose This study aims to conceive and develop a pricing model for the Ijara contingent convertible contract (ICCC, hereafter), considering the possibility that the lessee may default. The ICCC model grants the lessor the option of converting the unpaid amount into equity or recovering the leased equipment and selling it at market price in case of financial distress. Design/methodology/approach The ICCC is consistent with the profit-sharing approach and the new risk management techniques, which are compatible with Islamic philosophy. Relying on real options theory and the contingent claim approach, a closed-form solution of the firm’s assets is developed in a dynamic environment, where the rate of return is generated by a Cox-Ingersoll-Ross stochastic process. Findings Examining the numerical analysis reveals the impact of the firm value, the conversion or sell decision and the conversion ratio and volatility on the ICCC value. The value of the ICCC can increase substantially as the value of the firm approaches the conversion threshold. The conversion ratio as well as the asset market price play equally an important role in the decision to convert or sell. Originality/value This paper develops a pricing model for a contingent Ijara contract, which incorporates a conversion option to mitigate the lessee’s credit risk during periods of economic instability. The ICCC is a cooperative strategy that would be advantageous to all parties, including the lessor and lessee. In the event of a conversion, businesses may be able to continue operating thanks to this financial innovation, and the lessor may profit from the company’s recovery by freeing up more resources for the use of more profitable ventures.

Foreign business exposure, policy uncertainty, and investment allocation decisions of Chinese multinational corporations

Using unique subsidiary-level data of 3863 Chinese non-financial firms from 2000 to 2019, we document that the multinational firms have 5.3 % higher capital expenditures than domestic firms, relative to the average. After decomposing firms' investment into domestic and offshore investment, we find that the increased capital expenditure of multinational firms results from their offshore investment allocation in response to policy uncertainty in the domestic market. Our analysis suggests that, in the face of domestic uncertainty, multinational firms switch to their offshore markets as a means to reallocate investment, rather than in response to offshore investment opportunities, access to foreign capital, or domestic competition. Overall, this paper helps us better understand the real options theory in the context of international business.

Hybrid offshore wind projects. Social desirability vs. incentives to invest

To unlock the full potential of offshore wind requires investment in a more integrated offshore grid infrastructure combining generation and interconnection between countries in so-called hybrid projects. Taking the perspective of a social planner, these projects may result in more efficient allocation of scarce resources. Alas, the distribution of this welfare gain may result in disagreement on what grid design is the most attractive, what markets should be connected and whether and when to invest. To examine these dilemmas, we apply real options theory to investments projects with different grid design and market characteristics. We compare the incentives to invest in a) only the wind farm and b) both the wind farm and the grid infrastructure, assuming the project value of the last alternative can serve as a proxy for social welfare. Solutions are derived using a simulation approach called least squares Monte Carlo method. We find: 1) Non-stationary stochastic prices and/or decreasing costs may make it socially optimal as well as commercially beneficial to postpone even profitable investments. 2) Connecting markets is socially desirable but may reduce the offshore wind investor's project value. 3) Connecting markets with different characteristics is socially desirable but reduce the offshore wind investors' project value.

Data-driven corporate growth: A dynamic financial modelling framework for strategic agility

This research aimed to develop a Dynamic Financial Growth Model (DFGM) to enhance corporate growth by promoting strategic agility through data-driven decision-making. The main objective was to optimize corporate value by integrating real-time data, dynamic decision-making, risk management, and scenario analysis. The research employed a mathematical modelling framework that combined predictive analytics, real options theory, and scenario-based optimization to represent dynamic corporate financial decisions. The numerical example demonstrated how the model adjusts strategic decisions in response to changes in market data and evaluates corporate value under optimistic, pessimistic, and baseline scenarios. The main results indicated that the DFGM is effective in optimizing corporate value by allowing for continuous adjustments and strategic flexibility, distinguishing itself from traditional static financial models that lack real-time adaptability. The findings highlighted the value of incorporating risk constraints and scenario analysis, resulting in a balanced approach that manages both growth and uncertainty. However, the study identified limitations, including the need for empirical validation, more complex predictive analytics, and accounting for behavioral factors affecting decision-making. The conclusion emphasizes that the DFGM provides an adaptable and data-driven framework that enhances corporate strategic agility, making it a valuable tool for managing growth in rapidly changing environments, while also suggesting future research to refine the model's practical application

Exploring the Usefulness of Real Options Theory for Foreign Affiliate Divestments: Real Abandonment Options’ Applications

Scholars propose that future research on real options theory should shift attention away from option buying during the first investment stage and toward option execution after investment. Researchers maintain that it would be interesting to explore the circumstances under which investors decide to withdraw their investments, thereby exercising the option to abandon their investments. The present research seeks to fill the gap in the literature and investigate the applicability of real options theory when an organization enhances sustainability policies while focusing on disciplined capital allocation through exit strategies. With case study data on Natura &Co’s divestment strategy for the Body Shop in November 2023, a real options analysis revealed the method’s practical advantages and disadvantages. This paper investigates real options theory in the context of the divestments of foreign affiliates, providing unique viewpoints and enhancing the theory beyond previous knowledge while also increasing our understanding of the divestiture phenomenon. This study concludes with a review of this paper’s theoretical contributions to real options theory, the managerial and practical/social implications of real options applications in general, and the valuation methods of abandonment options in particular, shedding light on the potential of future research.

The impact of country level investor protection on economic policy uncertainty and corporate investment link

AbstractWe examine the relationship between economic policy uncertainty (EPU) and corporate investment in a global setting based on the real options theory and the agency theory. Using a sample of 44,610 firms from 28 countries, we find that the negative relationship between EPU and investment is more pronounced in the countries with stronger investor protection. In the countries with stronger investor protection, the negative impact of EPU on firms' capital investment is significantly stronger for the firms with more irreversible investment. Further evidence shows that the reduction of investment is mainly from overinvestment firms in the countries with stronger investor protection. Our evidence suggests country level investor protection can act as effective governance mechanisms that mitigate agency problems when firms are facing uncertainty.

Impact assessment of the residual lifespan of coal-fired power plants on the investment risk of carbon capture and storage retrofit

This research constructs an assessment model for carbon capture and storage (CCS) retrofit of coal-fired power plants (CFPP) by adopting the real option theory. Due to the prohibitive costs associated with retrofitting and insufficient residual lifespan of CFPP, CCS projects may fail to recoup their investment before units are decommissioned. The key contribution of this paper is that it investigates the impact of the residual lifespan of the units on the failure rate of the retrofit investment in addition to the optimal timing of the unit's CCS retrofit. Considering different installed capacities, utilization hours, clean energy subsidy and carbon trading mechanism, this study sets up seven scenarios to assess the impact of different investment environments on the value of project investment. In terms of sensitivity analysis, the residual lifespan of the unit, its interaction with carbon price, carbon price volatility, technological advancement rate, and subsidy level are examined for their impacts on the project investment risk. The findings suggest that the critical period for determining the long-term success of most coal-fired unit retrofits may be present, and more supportive policies need to be examined to facilitate the green transformation and upgrading of coal-fired units.

Investment decision analysis of shipping desulfurization project based on a fuzzy real option approach

ABSTRACT This study addresses shipping companies’ compliance with the International Maritime Organization’s 2020 sulfur emission limits, providing guidance for investment decisions in desulfurization projects. The paper uses a novel RCFM model, integrating real option theory (R), shipping cycle theory (C), fuzzy set theory (F), and Monte Carlo simulation (M). Key findings are: (1) During high oil price volatility, traditional binary tree models show computational distortions corrected by Monte Carlo simulation, whereas in lower volatility, the fuzzy binary tree model offers reliable investment intervals. (2) Investment in desulfurization depends on remaining vessel life and fuel price differences. For example, during the recovery period, for vessels with a remaining life of less than 5 years, investing in a desulfurizer is profitable if the fuel price difference exceeds $550/t and using low-sulfur fuel is advisable if below $400/t. For vessels of remaining life of 5-9 years, invest in a desulfurizer if the difference exceeds $500/t and use low-sulfur fuel if below $300/t. For over 9 years, invest in a desulfurizer if the difference exceeds $450/t and use low-sulfur fuel if below $200/t.

The impact of corporate climate risk perception on green outward foreign direct investment.

How to address climate risks and achieve green transformation has become a critical issue that businesses urgently need to consider. We apply growth option theory and prospect theory to examine the impact of corporate climate risk perceptions on green outward foreign direct investment (GFDI) using a research sample of heavily polluting listed companies in China from 2009 to 2022. Our findings reveal that companies with higher perceived climate risks tend to increase their inclination towards GFDI, and the informal hierarchy of boards reinforces the positive effect of both. Supplementary analyses indicate that through GFDI, corporations can exert positive effects on their own environmental performance and future green innovations. The positive impact is notably more visible in nonstate-owned companies and sample units from provinces along the Belt and Road. These findings extend the economic consequences of climate risk at the firm level from the perspective of international business research and provide empirical references for firms to promote their own green transformation from a practical perspective.

A Study of Asian Chooser Options in a General Two-Period Binomial Model

Asian options are also known as average price options, and their strike price is the average price of the stock in the market half a day before the strike. Binomial model is a good model to identify the value of options, The paper develops the theory of Asian chooser options in the two-period binomial model. There are Asian call options, and Asian put options. We first derive the binomial model of the Asian option and get the portfolio function. After that, we get the number of bond and stock, Nb and Ns. We study the problem via five different cases in the two-period Binomial model. In these five cases, we choose the maximum value between Asian put and call options. Then, we decide whether they are call options or put options. Then, we calculate the number of portfolios in these five cases in the two-period binomial model. Finally, we implemented the whole project with Python.

Heterogeneous effect of economic policy uncertainty and firm financial performance: Empirical evidence from India

AbstractGlobally, high levels of economic policy uncertainty (EPU) have revamped the debate about its impact on different economic parameters of firms. In this regard, the literature exhibits three gaps. First, the effect of EPU on firm financial performance in an emerging economy context. Second, whether the influence of EPU on firm performance is asymmetric? Lastly, the moderating role of leverage in the relationship between EPU and firm performance. This paper fills all three gaps using the real options theory and investment irreversibility theory for India's NIFTY 100 firms over the period 2010–2019. The study applies several panel data econometrics models suitable to obtain comprehensive and robust results. Specifically, findings from the two‐step system GMM confirm that EPU negatively influences financial performance, which is significant for both accounting (return on assets, return on equity, net profit margin) and market (Tobin's Q) based measures. Moreover, the results of panel quantile regression reveal considerable heterogeneity in the EPU‐financial performance relationship. Further, higher levels of EPU appear to have unfavorable effects on excessively indebted firms. Overall, the study recommends that governments need to be alerted to the fact that mitigating EPU is crucial for promoting sustainable firm financial performance.

How do financial constraints and market competition affect innovations: Evidence from Vietnam

This study delves into the effects of market competition and financial constraints on innovation within a transitional market. We implemented the Two Stage Least Squares regression to analyze a sample comprising 492 listed firms in Vietnam from 2008 to 2020. Our findings unveil an inverse U-shaped relationship between market competition and R&D intensity. Secondly, our study highlights the significant negative impact of financial constraints on R&D intensity. Thirdly, our research demonstrates the robustness of the nonlinearity of competition within small and medium-sized enterprises (SMEs). Our findings are consistent with agency theory, real options theory, and existing literature. Finally, our study offers practical implications for managers and policymakers aiming to foster innovation in developing countries, particularly amidst the digital transformation era.

The pure benefit of risk in production: real options in general equilibrium

An increase in the riskiness of a technology will raise economy-wide expected output: large productivity realizations lead to gains while small realizations are mitigated by using alternative technologies. Some usage of even the riskiest technologies can therefore bring Pareto improvements. The observed expected output of risky technologies can nevertheless be less than that of safer technologies: empirical estimates of expected output are therefore a poor measure of efficiency. Firms will adopt the efficient riskier technologies when markets are competitive, contrary to the view that innovation requires a monopoly reward. These results require a suitable definition of risk for general equilibrium models and a refinement of competitive equilibrium that allows for information discovery. The efficiency gain of increases in risk is related to real options theories of investment but applies even to single-period economies.

Firm-level political risk and corporate R&D investment

We examine firms’ investment decisions in research and development during political uncertainty using US firm quarterly data from 2005 through 2021. By using quarterly data, we minimize stickiness and overly generalized assumptions. The findings show that firms invest more in research and development in times of high political risk. Monetarily, the significance translates to about $10.6 million injection into research and development. The results are more pronounced for firms in competitive industries, politically sensitive firms, firms with higher growth opportunities, and firms with more liquid assets. The results are robust to the test for correlation, addressing endogeneity, and alternative proxies adopted for the variables of interest. Overall, the findings of this study support the strategic growth option theory, which suggests that firms follow a preemptive strategy in periods of high uncertainty.

Pricing VIX options based on mean-reverting models driven by information

Financial time series are dynamic and influenced by different types of information from the market. In this study, we propose new models for SPX and VIX options using the Hawkes process, jump process with stochastic intensity, and tempered stable process to capture these changes in financial time series based on three distinct characteristics of market information. We calculate the VIX option pricing formula using these models and find that the simplified VIX model based on VIX characteristics has significantly less pricing error than the consistent VIX model derived from the SPX model. Additionally, our findings suggest that the tempered stable process effectively models the volatility of VIX, sparse large jumps, and infinitesimal jumps. It also shows potential as an alternative to Brownian motion for representing volatility. Conversely, jump processes with stochastic jump intensities adeptly describe asymmetric jumps, and their integration with Brownian motion provides a more accurate depiction of the VIX’s volatility and jump dynamics. Finally, the introduction of jump processes into mean-reverting models for the VIX indicates a relatively low correlation between volatility magnitudes and the current VIX levels. This research contributes to the theory of SPX and VIX options and offers guidance for the development of other information-driven economic models.

Tourism digital transformation and future supply chain competition: an integrated perspective on real options theory and digital competencies

PurposeThis study analyzes how digital technologies collaboration, and technological capabilities affect tourism products' advantage and supply chain resilience via virtual integration and customer service capabilities.Design/methodology/approachTo achieve the goals of this study, a digital transformation model was formulated based on the real option theory (ROT) and digital competencies perspective. Data were collected from travel agencies in Taiwan. This study uses the partial least square structural equation modeling (PLS-SEM) technique to analyze the research model, and 384 samples were collected from travel agencies for analysis.FindingsThe research results point out that digital technology collaboration and technical capabilities affect virtual integration and customer service capabilities; customer service capabilities should also be regarded as key influencing variables to improve tourism product advantages and supply chain flexibility.Originality/valueThis study shares a unique perspective on the digital transformation model, which includes antecedents, mediators and moderators, to construct the critical effects for analyzing the tourism products' advantage and supply chain resilience.

Embracing certainty in uncertain times: Macroeconomic uncertainty, third‐party assurance, and CSR performance

AbstractOur study investigates whether macro‐level uncertainty on the future economic prospects, referred to as macroeconomic uncertainty, affects corporate social responsibility (CSR) performance. Two competing theories, namely, the real options theory and the risk management theory, offer different perspectives on whether firms would increase or decrease their CSR performance in response to macroeconomic uncertainty. Existing literature documents inconclusive empirical evidence about this matter. Employing a novel and unbiased measure of macroeconomic uncertainty and drawing upon data from U.S. firms between 2006 and 2017, we find that CSR performance is negatively associated with macroeconomic uncertainty. We also document that the negative association between macro uncertainty and CSR performance is attenuated for firms that have their CSR reports independently assured by third‐party experts. The results are robust to controlling for firm characteristics, an alternative measure of macroeconomic uncertainty, and an alternative sample period excluding the 2008–2009 Financial Crisis.